Will the hike in import duty curb gold consumption?

To curb the widening current account deficit, the government hiked the import duty on gold and platinum to 6 percent from 4 percent earlier this week. The objective in doing so, was to curb gold consumption and hence imports, which would put less pressure on the current account deficit, which in turn would help sustain the rupee.

The rationale of hiking import duty

A Reuters report has said that India's gold imports are set to break through a target ceiling of $38 billion in the year to March 31, 2013, tying up funds in what New Delhi sees as non-productive investment.

Import of gold and crude oil sees the trade deficit (imports-exports) rising. When imports start increasing sharply over exports, it puts pressure on the current account deficit and hence the currency. By hiking duty on gold, the government plans to discourage gold consumption, which in turn would reduce imports and hence the trade and current account deficit.

Will the increase in duty help?

Soon after the measure noted investment bank and broking firm Nomura said that India's hike in the gold import tax will only shift gold shipments to "unofficial channels".

"Therefore, in our view imposing import duty tackles the symptom, not the cause," Nomura said in a note.Analysts have all along voiced concern that increasing the duty on gold, would increase smuggling. It's possible that a 50 per cent hike in duty, could result in people looking at unofficial channels to bring in gold. "The government's move to hike the customs duty from 4 to 6 percent will have a loud impact on the Bullion sector. The hike sums up to around INR 60,000 (approx) per kilogram of gold. To be clear, with this duty hike a difference of 7 percent between the international and domestic price of the yellow metal is evident. This may lead to rise illegal channels and malicious activities with respect to importing gold and related products like jewellery etc., in the country. In turn it will lead to an increase in unemployment among the skilled artisans of the country (around 1-2 million people depend on this sector to earn their livelihood) as well the businesses of local jewelers across the country," Mr. Prithviraj Kothari, Managing Director, RiddiSiddhi Bullions Ltd said.

Indians buy jewellery, due to their own social compulsions and also as hedge against inflation. In the last few years the price of gold has doubled, but ironically imports have also increased.

Gold has low elasticity to price and hence increasing the price through import duties is unlikely to reduce consumption.